FINRA feels broker pushback on side-business proposal

Brokers and industry groups are greeting a FINRA proposal meant to relax advisors’ obligation to report side hustles like weekend bartending gigs with a big “thanks but no thanks.”

The Financial Industry Regulatory Authority, the brokerage industry’s self-regulator, has received roughly 200 comments in response to its proposal to simplify rules requiring brokers to keep their firms informed about sources of income they may have on the side. The proposed changes are primarily meant to prevent advisors from violating regulatory requirements for outside business activities like weekend bartending gigs or umpiring shifts at little league games.

But that’s not what’s stirring up controversy. 

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Rather, firms and industry groups are questioning a provision they say would give broker-dealers greater oversight responsibilities for brokers who are dually registered as advisors through separate, unaffiliated RIAs. FINRA’s proposal would not require broker-dealers to monitor the activities of advisors who merely use their position at an outside RIA to recommend investments to clients. But opponents contend it would mandate oversight of any advisor who “effects or places a securities order” through an unaffiliated RIA.

Advisors under different ‘regulatory regime and schematic’

That, according to critics, goes well beyond anything FINRA had required before. In a comment letter dated April 10, the broker-dealer Purshe Kaplan Sterling Investments noted that FINRA has billed the changes under consideration as a proposal “to Reduce Unnecessary Burdens and Simplify Requirements Regarding Associated Persons’ Outside Activities.” FINRA’s proposal, according to PKS, “will not serve to achieve either of the stated goals, but will rather add additional ambiguity and burdens on both member firms and unaffiliated Registered Investment Advisory firms (‘RIAs’).”

PKS CEO J. Peter Purcell, who wrote the letter, said in an interview last week that he appreciates “the fact that public clients deserve the highest level of care to stop any inappropriate behavior from their financial advisors.” 

“What I don’t agree with is that it’s my responsibility to oversee activities of an advisor at an unaffiliated firm,” Purcell said. “If they’re not working at my firm, I shouldn’t have to be responsible or have a private right of action against me, either regulatory or arbitral for behavior that I have no business looking at.”

In both his letter and in speaking with FP, Purcell said that FINRA rules already require advisors to report to their broker-dealers any “private securities transactions” they place on behalf of clients. Private securities transactions generally refer to investments in limited partnerships, promissory notes and other instruments traded outside regulated public markets.

“And this has been inexplicably misinterpreted to now apply to advisory activities, which are under a completely different regulatory regime and schematic,” Purcell told FP.

FINRA’s statement to correct misinformation

FINRA, for its part, maintains it isn’t imposing any new requirements for brokers to monitor unaffiliated RIAs. In a “Statement to Correct Misinformation About FINRA’s Outside Activities Proposal” earlier this month, the regulator wrote that “The proposal does not change the existing obligations regarding unaffiliated investment adviser activity ….”

Instead, according to the post, FINRA is merely asking whether “it should reduce or eliminate current obligations for unaffiliated investment adviser activity.” Jim Wrona, FINRA vice president and associate general counsel, said in an email that FINRA’s proposal “maintains the status quo” but entertains the possibility of reducing brokerage firms’ oversight requirements even further.

FINRA has received comment letters in past years saying broker-dealers should have no responsibility to monitor the activities of advisors at unaffiliated RIAs. “In addition, commenters noted that investment adviser activities are subject to a fiduciary obligation and are regulated by the states and the SEC,” Wrona said by email.

Broker-dealers’ concerns shared by many RIAs

But industry representatives aren’t buying what Purcell referred to as FINRA’s “nothing to see here” defense. Purcell’s concerns are shared by many of his colleagues on the RIA side of wealth management.

Erik Randall, the chief compliance officer of the registered advisory firm Summit Wealth Group, wrote in a letter dated May 13 that the proposal “would subject affected advisors to additional oversight that doesn’t exist for investment advisory firms that do not have associated persons with FINRA licensure.”

“This uneven layer of oversight is unjustified, as there is no evidence that broker-dealer oversight of investment advisory transactions provides any meaningful protection for advisory clients,” Randall wrote.

Randall and Purcell both noted that the Securities and Exchange Commission has rules calling on advisory firms to keep client information confidential. That requirement could easily be violated, Randall wrote, if advisories were required to furnish transaction data to unaffiliated brokerage firms.

“Providing unaffiliated broker-dealers access to confidential advisory client information exposes the client’s sensitive financial information to parties who are neither entitled to it nor directly responsible for managing the client’s assets, thereby violating the advisor’s ethical obligations regarding client confidentiality,” he wrote.

Extending the long arm of FINRA

Other letters suggest the proposal is an attempt to extend FINRA’s oversight authority beyond the broker-dealer industry and into the world of RIAs. In a letter dated April 21, Charles Kitsman of the advisory firm Kitsman Investment Management noted that RIAs are already regulated by the SEC and the states.

“Imposition of FINRA Rules, that are in no way related to my business, on only those RIA firms that have person(s) also registered with a FINRA member creates an uneven regulatory environment and serves no purpose other than an unwarranted expansion of FINRA’s jurisdiction,” Kitsman wrote.

Some critics have contended that FINRA’s proposal would require advisors to also get their broker-dealer’s approval before investing their own money in assets like cryptocurrency or real estate. In an editorial this month in the industry publication ThinkAdvisor, the crypto enthusiast Ric Edelman contended “this rule would require you to get written permission from your firm before you’d be permitted to purchase a beach house. You’d also have to get your firm’s approval to buy any type of insurance — life, auto, homeowners, health, and whatnot.”

FINRA flatly denied Edelman’s assertions in its “Statement to Correct Misinformation” and Edelman later acknowledged to Barron’s that it “appears that the final rule will not impose the objectionable undue burden that I wrote about, and this is a welcome development.”

But Purcell warned in PKS’s comment letter that FINRA’s proposal could require broker-dealers to monitor transactions advisors make to clients in “wholly unrelated” industries such as banking, real estate and insurance.

“Given that each of these business lines, particularly banking, are complex, and banking in particular is already heavily regulated, we respectfully but forcefully disagree with that stance,” Purcell wrote.

Much undue ado about outside business activities?

As for the original goal of FINRA’s proposal — to prevent brokers from having to report outside business activities unrelated to investments — Purcell said he’s not even sure it’s desirable. FINRA has said it wants to “both increase investor protection and decrease burdens on members by eliminating the reporting and assessment of low-risk activities that create white noise (e.g., refereeing sports games, driving for a car service, bartending on weekends).”

FINRA’s current reporting requirements for outside business activities have been a thorn in the side of many in the industry for years, sometimes leading to fines and industry suspensions for individual brokers. The rules are generally meant to eliminate conflicts of interest that could cause brokers to issue recommendations that aren’t in keeping with their clients’ interests.

Purcell said he can still see a case for why brokerage firms should have some idea about how their representatives are supplementing their incomes outside regular business hours. It’s not as if, he said, the information is difficult to collect.

“Someone sends an [outside business activity] form to us, which we make everybody fill out, and says, ‘I’m going to tend bar on the weekends or drive an Uber,'” he said. “OK. We deem that to be extremely low risk. Thanks for letting us know, and we approve it. What’s so difficult about that?”